Mortgage life insurance is a special insurance policy designed to protect your family if you die before your mortgage is paid off.
The policy is structured so that when your mortgage is paid in full, the insurance policy terminates. This is done through a strict coordination between your bank and the insurer. However, there is a dark side to mortgage insurance. If you fail to understand how these policies fall apart, you may be left without adequate insurance coverage. Read also: Why You Need Mortgage Life Insurance.
The Decreasing Nature of Mortgage Insurance
When a mortgage life insurance policy is issued, the target date set for termination coincides with the last mortgage payment due. The insurance policy is a decreasing term policy. Normally, it’s set to terminate with a 30 year mortgage. For example, if you carried a $100,000 mortgage, your mortgage insurance policy would be for $100,000. When your mortgage balance decreased to $90,000, your term policy would be for $90,000 and so on.
The problem with this scenario is that mortgage insurance does not take into account refinances over the lifetime of the mortgage. If you need to refinance the home for repairs, or to build an addition onto the home, you’ll end up with a mortgage balance that exceeds the total value of the death benefit of the insurance policy. The difference between the death benefit and the new mortgage balance would be your risk exposure. Read also: Be a Wise Homeowner and Buy Mortgage Life Insurance.
Each year, the term policy would continue to decrease according to the original mortgage balance. If you died prematurely, the insurance would be enough to cover the original mortgage balance, but that’s it. The remaining balance would have to be paid by your spouse. This could create a significant financial hardship for your family.
How To Solve Lapse Issues
When your mortgage policy terminates, it’s called a “lapse.” To prevent this from happening, you need to add additional coverage at the time you refinance your home. The additional mortgage policy should equal the new mortgage balance.
An alternative way to handle this is to make a long-term plan when you first purchase your home. If you know, going into it, that you will do some remodeling, expansion or that you’ll do a cash-out refinance, then factor that into your life insurance purchase. Read also: 5 Valuable Life Insurance Tips to Consider When Buying Insurance.
Option 1 – purchase a level term policy instead of a decreasing term policy. This will give you the benefit of having coverage that stays level for the life of your loan thus eliminating the risk of being under-insured.
Option 2 – Buy whole life insurance. Whole life combines traditional insurance coverage with a savings component. Many whole life policies offer you the option of adding additional term insurance to the base policy. This makes the whole life policy more affordable. Since a whole life policy builds a cash value savings, you can use this as a source of funds rather than refinancing your home. It prevents you from becoming under-insured and is guaranteed to remain in force until your age 100. You can also use the cash value to pay off your mortgage balance early if you so desire, thus eliminating your need for mortgage protection. Read also: 10 Year Term Life Insurance Strategies.
Get several mortgage life insurance quotes before you do anything. Then, get at least two whole life quotes. You’ll notice the premiums for whole life are higher, but this is due to the fact that most of the premium goes towards building cash value. After considering your long-term goals, you can make a decision that will be the most beneficial for you and your family.